1) may 2015
THE INVESTOR
NAVIGATING THE CREDIT MARKETS
Portfolio Manager Viewpoints
Bank loans have had a strong start in 2015. Positive technicals, improved risk sentiment, and a snapback in energy credits have been the
primary drivers. In this commentary, Portfolio Managers Jason Rosiak,
JP Leasure, and Michael Marzouk discuss the bank loan market and their
2015 outlook.
Rosiak: Entering 2015, valuations for credit assets, notably bank
Start at the top, assess the capital market environment
loans and high yield, were attractive given the weakness seen in late
2014. An improvement in risk sentiment and technicals along with an
energy market rebound have created above coupon returns thus far.
As we enter the middle of 2015, focus remains on the Federal Reserve
and the timing of a tightening cycle. Market sentiment would benefit
from a slow and low path to policy hikes, which is conducive for credit
risk given a &ldquo;good enough&rdquo; economic backdrop and stable corporate
Going with the Flow
Recent fund flows and technicals have helped fuel above coupon
returns for bank loans thus far in 2015.
Floating rate mutual fund flows have turned positive over the
past two months, and may continue if duration is a headwind
to fixed income returns
10
Monthly floating rate mutual fund flows ($bn)
8
6
4
2
0
-2
fundamentals. With unattractive valuations on government debt, we
-10
Table 1: 2015 has thus far been a reversal of 2014, with credit
Source: Lipper, as of May 24, 2015
believe credit will continue its relative outperformance.
risk outperforming duration risk
High Yield
2.45
2015
Aggregate
5.97
1.00
Bank Loans
Int Corporate
Agency MBS
Treasury
2.07
4.35
6.08
5.05
Source: Barclays, Credit Suisse Indices, as of May 29, 2015
4.07
December&rsquo;s $8bn outflow
was a record
-8
2013
2014
2014
2014
2015
2015
3.19
Demand is outpacing net supply for the first time since 2012
0.92
100
1.82
1.08
Leasure: The past year has seen two distinct periods. The headwinds
Describe the bank loan market performance over the past year
of late 2014, caused by poor technicals, risk aversion, and energy related volatility. Thus far in 2015, these factors have reversed, becoming tailwinds as bank loans have returned above coupon.
-6
2013
2014
Total Return (%)
-4
200
Bank loan surplus/(shortfall) ($bn)
151
150
117
80
50
36
38
0
(11)
19
6
3
(3)
(9)
(0)
(4)
(5)
-50
(56)
-100
2001
2003
2005
2007
2009
2011
2013
2015
Source: JP Morgan, as of May 29, 2015. Surplus/shortfall takes net primary issuance and subtracts retail fund flows and CLO issuance to get a
net demand. A positive number means supply outpaced demand.

2) portfolio manager viewpoints
may 2015
Marzouk: Technicals in the bank loan market have been critical
What will be the impact of Dodd-Frank and the risk retention
particularly true in December as fund outflows accelerated into
will be required to retain 5% of each tranche of the capital struc-
in the short term. With the growth of floating rate mutual funds
to more than $130bn versus $43bn in 2010 (Source: Lipper), fund
flows appear to be influencing short term performance. This was
a seasonally weak liquidity environment (Chart 1). Given the
strength of institutional demand through CLO issuance and limited net supply, the technicals became a tailwind in the beginning
part of 2015 (Table 2). Also, since bottoming in March, loan fund
flows have turned mildly positive as duration has become a performance detractor, a reversal from the previous year.
Chart 1: Ending a streak of twelve consecutive months of outflows, fund flows have turned positive in the past two months
10
Floating rate mutual fund monthly flows ($bn)
8
Marzouk: As part of Dodd-Frank legislation, sponsors (aka asset
for CLO issuance?
managers) of any structured product (CMBS, CLO, CDO, RMBS),
ture beginning in 2017. The goal is to incentivize better collateral
management and deal structures by requiring sponsors to have
&ldquo;skin in the game.&rdquo; While loan managers and the LSTA fought hard
against the ruling, CLO&rsquo;s were not given an exemption. The capital
requirements could be onerous for smaller or independent asset
managers, potentially impacting issuance in the future.
Rosiak: In the immediate term, we believe we will see a pulling
forward of demand, which will continue to support the technical
picture in 2015. However, into 2016, as some CLO&rsquo;s reach refinanc-
ing windows, we may see a tapering of issuance given the concerns
towards retention requirements.
6
4
Chart 2: While CLO issuance is expected to remain high in
2
0
2015, concerns towards refinancing risk and the retention re-
-2
quirements may curtail 2016 issuance
140
-4
-6
120
Negative technicals in late 2014
impacted total returns
-8
2012
2013
2013
2014
94
100
-10
2012
2014
2015
Source: Lipper, as of May 24, 2015
Table 2: Demand has outpaced supply thus far in 2015, helping
Gross Issuance
$bn
Paydowns
Repricings
Total Net Supply
Retail Inflows
301
2012
670
2013
467
2015
188
44
2014
(200)
(260)
(188)
12
63
(24)
80
(37)
64
(242)
169
CLO Issuance
Total Demand
56
87
68
150
Surplus/(Shortfall)
(4)
19
(91)
132
108
146
(59)
(43)
(5)
54
49
(5)
Source: JP Morgan, as of May 29, 2015. Surplus/shortfall takes net primary issuance and subtracts retail fund flows and CLO issuance to get a net demand.
A positive number means supply outpaced demand.
90
87
80
60
to buoy prices and create a positive tailwind
132
Annual CLO issuance ($bn)
40
20
56
52
29
21
19
14
1
0
2003
2005
2007
54
2009
4
2011
2013
2015
Source: JP Morgan, as of May 29, 2015
How do you articulate energy related volatility and its impact
Leasure: While only 4% of the Credit Suisse Leveraged Loan Inon bank loans?
dex is energy related versus 14% for the Barclays High Yield Index,
volatility has been significant, impacting returns. Negative price
action for energy issuers hit its peak in late January, coinciding
with oil reaching $44 per barrel (Chart 3). Since late January, the
stabilization in oil prices along with a positive risk environment
has led to an improvement for energy credits. We have seen high
quality energy issuers improve the most in price. This is indicative
of a market evaluating issuers on underlying fundamentals versus
the highly correlated selloff seen in late December.
2

3) portfolio manager viewpoints
may 2015
Chart 3: Energy issuers have seen a strong improvement in
prices following the December/January volatility
8
Monthly return of the CSLLI Energy Sector (%)
3.6
4
2
0.9
0
1.5
0.5 0.5 0.1 0.6 0.9 0.4 0.4
-2
hedges. The amount of defaults will be dependent upon a combination of the price of oil, asset valuations, capital market conditions,
and refinancing risk.
5.4
6
terialize until 2016, given the stabilization in oil and production
Chart 4: The lack of refinancing risk supports a below average
default rate
(1.0) (1.2)
(1.7)
-4
(4.0)
-6
-8
250
Maturity profile ($bn)
200
(1.0)
High Yield Bonds
Bank Loans
150
(8.8)
-10
Jan-14
Mar-14 May-14
Jul-14
Sep-14 Nov-14
Jan-15
Mar-15 May-15
100
Source: Credit Suisse, as of May 29, 2015
Rosiak: We do not find valuations sufficiently appealing to inDo you look at the energy sector as an attractive opportunity?
crease our energy exposure. First, while we have selective energy
issuers in the portfolio, it is not our preference to have issuers with
equity like volatility in our strategy. Second, a lot of the short term
volatility around energy is being driven by the price of oil, which
is very difficult to forecast. Third, energy issuers have seen strong
price improvement since February, removing some relative value
opportunities for many credits.
Marzouk: We have seen a reversal in technicals and risk sentiment
Describe the outlook for the second half of 2015
help propel bank loans to above coupon returns year-to-date. We
viewed the total return profile for 2015 as coupon plus, perhaps
5-6%. With such a strong first half, income and yield are likely to
drive total returns for the remainder of the year versus the price
performance seen thus far. The wild cards will be energy and met-
als/mining sectors, which have the ability to impact the couponlike return profile.
We have discussed the valuations and technicals. What about
Leasure: Our theme in loans over the past few years has been
the fundamental outlook?
limited refinancing risk, right sizing of corporate balance sheets,
and slow but positive U.S. GDP growth extending the credit cycle,
creating a favorable fundamental backdrop. U.S. corporate profits
are continuing to generate free cash flow and provide the ability
to service debt. Refinancing risk remains minimal, reducing the
risk of a maturity wall or surge in defaults due to lack of access
to capital markets (Chart 4). Excluding energy and metals/mining
companies, there remain a limited number of default candidates in
the near term. Meaningful defaults for energy issuers may not ma-
50
0
2015
2016
2017
2018
2019
2020
2021
2022
2023
2024
Source: ML/BOA as of April 30, 2015
What are your portfolio positioning and themes for the second
Rosiak: As is our style, we are focused on the larger companies
half of 2015
within the bank loan universe. We are overweight B vs. BB rated issues given the favorable fundamental backdrop. We are overweight
housing, retail, and service sectors and underweight healthcare,
utility, and technology. We seek to minimize exposure to eurocentric companies due to weak profit growth and systemic risks.
We hold limited high yield bonds (less than 2%), favoring an over-
weight to second lien bank loans. It is our opinion that the volatility
profile of high yield negates the income advantage for bonds over
loans. We believe second lien loans are a more attractive way to
capitalize on higher returns.
Leasure: We have seen non-CLO demand for bank loans over the
How would you articulate the value proposition for loans?
past three years driven by the ebbs and flows around concerns of
higher rates. We view the asset class as a strong diversifier to traditional fixed income given the lack of duration, focused credit risk,
yield advantages, and the limited correlation to other traditional
fixed income asset classes. Regardless of one&rsquo;s view on interest
rates, the low absolute yield levels of traditional fixed income com-
bined with stable credit fundamentals paints a favorable relative
value picture for loans.
3

4) portfolio manager viewpoints
may 2015
Should rates move higher, or a taper tantrum similar to 2013 develop,
bank loans have the added benefit of being a potential hedge against
that volatility.
Summary: Following a weak 2014, bank loans have seen a snapback
in performance as technicals and risk sentiment have improved.
A combination of stable fundamentals, &ldquo;good enough&rdquo; economic
growth, and low absolute yield levels on traditional fixed income
paint a favorable relative value picture. Given a coupon like return
profile of 5-6% with a lack of duration risk, bank loans continue to
serve as an excellent diversifier for traditional fixed income.
Pacific Asset Management
May 2015
ABOUT PACIFIC ASSET MANAGEMENT
Founded in 2007, Pacific Asset Management specializes in credit oriented fixed income strategies. Pacific Asset Management is a division of Pacific Life Fund Advisors
LLC, an SEC registered investment adviser and a wholly owned subsidiary of Pacific Life Insurance Company. As of March 31, 2015 Pacific Asset Management managed
approximately $4.8bn.
IMPORTANT NOTES AND DISCLOSURES
Bank loan, corporate securities, and high yield bonds involve risk of default on interest and principal payments or price changes due to changes in credit quality of
the borrower, among other risks. Pacific Asset Management is an investment advisor; it provides investment advisory services to institutional clients and does not sell
securities.
This information is presented for informational purposes only. This is not to be construed as an offer to buy or sell any financial instruments and should not be relied
upon as the sole investment making decision. All material is compiled from sources believed to be reliable, but accuracy cannot be guaranteed. The opinions expressed
herein are based on current market conditions and are subject to change without notice.
FOR MORE INFORMATION
Pacific Asset Management &bull; 700 Newport Center Drive &bull; Newport Beach, CA 92660 &bull; www.pam.pacificlife.com
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